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Outline of the Lecture
▪ PTAs & Economic integration
Types/degrees of integration
Traditional approach (revision):
Trade creation
Trade diversion
Kemp and Wan argument
▪ Economic geography of PTA creation Venables and Puga
▪ Political economy of trade policy Median voter
▪ Q&A time
Preferential Trade & Termites
Trade Liberalization
1. Unilateral liberalization
2. Multilateral liberalization – “we lower our
tariffs if you do the same with yours”
3. Preferential trade agreements
Options 1+2 have impacts described by
the traditional theory, but preferential trade
agreements may have also discriminatory
effects – does it matter?
Selective liberalization - again space for discussions
about “the second best”
PTAs/RTAs versus MFN▪ GATT/WTO
Based on non-discrimination MFN status
▪ Historical roots of the exception: Bhagwati (2008)▪ But PTAs can be understood as discriminatory
Exception from the MFN regime Article XXIV of GATT (for goods)
Allows creation of customs unions and free trade areas Basic conditions:
Creation of the PTA should not increase the level of protection imposed on trade with non-member countries (Par. 5)
Elimination of barriers to trade on substantially all trade among the members (Par 8)
Interim agreements possible, but it is necessary to set a target stating when the CU or FTA will be created
GATS article V Enabling clause for developing countries
▪ Other specific exception from MFN: Asymmetric liberalization for developing countries: GSP
Article XXIV
▪ 4. The contracting parties recognize the desirability of increasing freedom of trade by the development, through voluntary agreements, of closer integration between the economies of the countries parties to such agreements. They also recognize that the purpose of a customs union or of a free-trade area should be to facilitate trade between the constituent territories and not to raise barriers to the trade of other contracting parties with such territories.
▪ 5. Accordingly, the provisions of this Agreement shall not prevent, as between the territories of contracting parties, the formation of a customs union or of a free-trade area or the adoption of an interim agreement necessary for the formation of a customs union or of a free-trade area;
Source: http://www.wto.org/english/tratop_e/region_e/regatt_e.htm
Article XXIV (Par. 8)▪ (a) A customs union shall be understood to mean the
substitution of a single customs territory for two or more customs territories, so that (i) duties and other restrictive regulations of commerce (….) are eliminated with respect to substantially all the trade between the constituent territories of the union or at least with respect to substantially all the trade in products originating in such territories, and,(ii) subject to the provisions of paragraph 9, substantially the same duties and other regulations of commerce are applied by each of the members of the union to the trade of territories not included in the union;
▪ (b) A free-trade area shall be understood to mean a group of two or more customs territories in which the duties and other restrictive regulations of commerce (…) are eliminated on substantially all the trade between the constituent territories in products originating in such territories.
Article XXIV – Conditions (Par. 5, excertps)
▪ (a) with respect to a customs union, or an interim agreement leading to a formation of a customs union, the duties and other regulations of commerce … shall not on the whole be higher or more restrictive than the general incidence of the duties and regulations of commerce applicable in the constituent territories prior to the formation of such union or the adoption of such interim agreement, as the case may be;
Article XXIV – Conditions (Par. 5, excertps)
▪ (b) with respect to a free-trade area, or an interim agreement leading to the formation of a free-trade area, the duties and other regulations of commerce maintained in each of the constituent territories and applicable at the formation of such free-trade area or the adoption of such interim agreement to the trade of contracting parties not included in such area or not parties to such agreement shall not be higher or more restrictive than the corresponding duties and other regulations of commerce existing in the same constituent territories prior to the formation of the free-trade area, or interim agreement as the case may be;
From: Newfarmer
Stages of Economic Integration
▪ Interim agreement
▪ Free trade area (association)
Liberalization of mutual trade of the members
▪ Customs union
As FTA + common trade policy towards nonmembers
▪ Common market
▪ Economic union
▪ Effects of preferential (selective) cooperation are mostly analysed on customs union - i.e. theory of customs unions
How Common are RTAs/FTAs?
▪ Much more common that many non-economists realize There are about 400 RTAs/FTAs and a quite a few are being
negotiated now (TTIP, …) or they are awaiting ratification (TPP)
▪ DESTA data?▪ One of the biggest “sinners”: EU!▪ The resulting EU trade policy:
Until 2014 (a change in GSP) there were only few countries for which the EU used pure MFN status, most trade partners had either some RTA agreement or GSP (EBA, GSP+) In 2007 pure MFN regime applied to 9 countries (Australia; Canada;
Chinese Taipei; Hong Kong; Japan; Korea; New Zealand; Singapore; USA) 5 of them have an FTA under negotiation or negotiated (Korea, Japan,
Singapore, Canada, USA)
But 32 countries lost GSP in 2014 (and did not have any other form of preferential access) Example: Brazil, UAE
Source: WTO
Not just EU/USA: Chinese FTAs
▪ Existing:
China-ASEAN FTA, China-Pakistan FTA, China-Chile FTA, China-New Zealand FTA, China-Singapore FTA, China-Peru FTA, Mainland and Hong Kong Closer Economic and Partnership Arrangement, Mainland and Macau Closer Economic and Partnership Arrangement, China-Costa Rica FTA, China-Iceland FTA, China-Switzerland FTA, China-Korea FTA, China-Australia FTA
▪ Under negotiation:
GCC (Gulf Cooperation Council), Norway, Trilateral (Japan-Korea), RCEP, ASEAN, Sri Lanka, Maldives
▪ Under consideration (feasibility studies exist):
India, Columbia, Georgia, Moldova Source: MOFCOM
Partial view of the “Spaghetti Bowl” as viewed by Baier, Bergstrand & Egger in 2005
Article XXIV and Non-Discrimination: Just a Mirage?
▪ Even if member countries are required to not increase the external protection, there are some workarounds:
Bound tariffs v. applied tariffs
Administered protection
Rules of origin
Entrails of FTAs: Width and Depth
▪ Simple shallow FTA: merchandise trade, tariff barriers
▪ Wider and deeper FTAs: Merchandise: non-tariff barriers
Certification issues
Mutual recognition
Harmonization?
Services
IPRs
Investment rules
Government procurement
▪ Common issues: rules of origin (ROO)
▪ Depth and width cannot be often that easily disentangled: trade –investment nexus
Motives for FTAs▪ Economic perspective
Gains from trade Overall welfare (governments) Particular interest groups
▪ IPE perspective Market access competition Stabilization of economic reforms (lock-in), credible commitment
to some types of policies Lack of progress in multilateralism (Doha Round impasse)
▪ International relations Influence, economic dimension of political alliances
▪ Behavioural and other issues: Individual career considerations “Monkey see, monkey do”
Theory of Customs Unions
▪ Traditional - focusing on effects on the participating countries Static effects
Dynamic effects
▪ Analysis of implications for the liberalization in world trade & welfare How will formation of PTAs change the path towards
overall liberalization? PTAs as building blocks or stumbling blocks?
Time Dimension
▪ First regionalism Late 1950s, early 1960s Attempts at forming CUs and FTAs in developing countries
(also inspired by EEC) Interest in static effects
▪ Second regionalism Early 1980s USA abandoned the policy of avoiding PTAs Interest in the dynamic path
▪ 1990s new wave of regionalism Enlargement and deepening of the EU Interest in economic geography
Source: Freund & Ornelas, 2010
Liberalization: Benefits
1. Gains from trade related to specialization
2. Members may profit from increasing returns
3. Higher degree of competition, lower monopoly power
4. Small countries become large TOT effects of optimum tariff
Traditional literature focused on the first effect (and
comparative statics), more recent approaches stress
importance of the remaining factors (and their
implications for dynamics)
Traditional Approach
▪ Viner (1950): Customs Union Issue
▪ Two types of effects
▪ Trade creation – commodity that used to be produced domestically can now be traded potential efficiency and welfare gains
▪ Trade diversion - it is possible that we will not import from the most efficient producer country
▪ Traditionally - trade creation should have positive welfare effects and trade diversion negative
Trade Creation and Trade Diversion
▪ If 100% tariff was imposed initially, then customs union with either B or C leads to trade creation
▪ If we start from the situation with 50% tariff and form a customs union with B, it will result into reorientation of trade, trade diversion
Country A B C
Price 35 26 20
100% tariff 52 40
50% tariff 39 30
Trade Creation and Trade Diversion
Q
P
p1
p4
SROW
Sp
SROWT
p2
p3
SHDH
q1 q2 q3 q4
a b
c d e f
g h i
Probability of Beneficial Effects Increases,
▪ the greater is the degree of competitiveness among member countries
▪ the higher are the initial tariffs
▪ the lower are the subsequent tariffs with the outside world
▪ the wider is the union
Trade Diversion: Empirical Evidence
▪ Trade diversion is empirically relevant
MERCOSUR – Yeats (1996)
EU – Wei & Frankel (1996)
▪ Methodology of the econometric tests
Mostly based on modified gravity models
Intra- and Extra-“Block“ Merchandise Trade (2007)
Source: WTO
Trade Diversion & Welfare
▪ Trade diversion does not have to reduce welfare
▪ To guarantee that it indeed must reduce welfare, we need some fairly restrictive additional assumptions: linear PPF,
no substitution in consumption!
▪ Without these additional assumptions welfare implications of trade diversion remain ambiguous
Substitution in Consumption (1)Assume complete specialization – point P
Country A imports X in exchange for Y
Tariff has no distorting effect on production
and consumption
Trade diversion clearly decreases welfare
P
Y
X
CCT
CT
UC
B
UB
Substitution in Consumption (2)Assume complete specialization – point P
Country A imports X in exchange for Y
Tariff has no distorting effect on production,
but pattern of consumption can change now
Trade diversion has no effect on welfare
P
Y
X
CCT
CT
UC
B
= UB
Importance of the HO-like PPF
Y
X
UC
UB
Other Interesting Effects
▪ IRS, imperfect competition - higher volumes of production, higher competition
▪ Protection by quotas - no space for trade diversion
▪ VERs - no quota rents for the importing country
▪ Greater degree of certainty for business stimulates long-run gains
▪ Additional reasons that lead to conclusion that CUs and FTAs should have positive welfare effects
Dynamic Effects of Integration
▪ Changes in the growth rate resulting from expansion in the size of the market and the attendant addition of productive resources (Kreinin 1974)
▪ Cumulative nature potentially much more significant than static effects
▪ Associated with increase in competitive pressures following the removal of trade barriers and with increased scale
PTA Formation: Other Factors
▪ PTAs can bring additional administrative burden
Rules on origin of goods are necessary (problem especially for FTAs)
One country can be involved in multiple PTAs which can lead to quite complicated rules (e.g. EU)
▪ Possible increased endogenous protection against non-members
E.g. by resorting to antidumping measures more often?
Partial view of the “Spaghetti Bowl” as viewed by Baier, Bergstrand & Egger in 2005
PTA Formation and Welfare
▪ Kemp & Wan (1976) argument: PTA formation can be Pareto improving
It is always possible to create a PTA on a subset of countries without decreasing welfare of all other countries (and the PTA improves the welfare of the participants) – i.e. we can find an external tariff that makes this possible
Logic: We fix the vectors of imports, exports, and prices of the would-be PTA
towards other countries Then we allow the members to remove internal barriers and reorganize
their production and consumption (subject to the constraint given by the external trade vector)
Welfare of the non-members remains constant, welfare of the members is at least as good as before (we keep one constraint but remove others)
Caution: Kemp & Wan show that PTA can be Pareto superior (but not that it will be and must be!)
Alternative Time Paths under Multilateralism and PTA
Source: Bhagwati, Greenaway, Panagariya 1998, p. 17
World
welfare
CU Theory: Conclusions
▪ Regional integration differs from multilateral or unilateral integration
▪ Economic analyses has in the past concentrated mainly on Vinerian static effects, even though dynamic effects may be more important
▪ Integration increases interdepedence within the integrated markets
▪ Traditional theory has problems with both ambiguity of conclusions and with limited relevance for real-world customs unions
▪ Empirical issues – Freund & Ornelas (2010): “Empirically, neither widespread trade diversion nor stalled
external liberalization has materialized, while the undermining of multilateralism has not been properly tested.”
Why do some Many PTAs/RTAs exist?▪ Misunderstanding: free trade area ≠ free trade
▪ Political and strategic interests at country level Stabilization of achieved reforms
Alliance with important countries (protection)
▪ Private interests Careers and economic interests of policymakers and
diplomats
▪ Bhagwati: Ethnic interests and lobbies (USA)
▪ Inspiration & peer pressure Bhagwati (1998): “monkey see, monkey do”
Worries about exclusion
(New) Economic Geography: Brief Introduction(and Application on Customs Unions/Single Markets)
Economic Geography – Brief History
▪ Inspiration: Traditional economic geography Models of the optimal use of land - e.g. von Thünen Regional economics: central place theory Location models - e.g. Hotelling
▪ Modern theory - New Economic Geography P. Krugman, JPE, 1991: ``This paper develops a simple model that
shows how a country can endogenously become differentiated into an industrialized "core" and an agricultural "periphery."''
Krugman, Fujita, Venables, 1999: The Spatial Economy
▪ Defining features of New Economic Geography models General equilibrium Reliance on imperfect competition or indivisibilities at the level of
individual producer (plant); this also implies imperfect competition.
Transport costs.
Agglomeration & NEG
▪ When productive factors can cross borders (international or inter-regional) integration may have very different effects
▪ Scale economies & trade costs generate forces that encourage geographic clustering of economic activity.
"Overall clustering“ = some areas with lots of economic activity, others empty “core-periphery”
"Sectoral clustering" = each sector clusters in one region, but most regions get a cluster
Economic Geography of CUs
▪ Economic geography models Series of works mainly by Krugman, Fujita, Venables
▪ Interested in spatial allocation of economic activities▪ Center/core and periphery▪ Example: Puga and Venables (1995): Preferential
trading arrangements and industrial location Model with IRS, Dixit-Stiglitz competition, imperfectly
competitive industrial sector, model based on Krugman and Venables (1995).
Compares FTA and hub-and-spoke arrangements Formation of a PTA does not necessarily cause convergence
of the production structures and welfare levels of member nations
Hub-and-spoke arrangement favors location in the hub Version with 3 countries: trade liberalized between 1 and 2
Formation of FTA: Shares of Industry
From: Puga and Venables (1995), p. 18
Trade barriers
Formation of FTA: Welfare Effects
From: Puga and Venables (1995), p. 18
Trade barriers
POLITICAL ECONOMY OF TRADE POLICY
Trade Policy – Crucial Questions
▪ Why do we observe so much of trade policy intervention? Why is trade not free?
▪ Why do we often observe less efficient forms of policy even when more transparent and efficient forms be found?
E.g. why do we observe so many PTAs if there is a better solution available?
PE of Trade Policy
▪ Political economy tries to explain “why?” by looking at equilibria of political games
▪ We should be also interested in how the differences in the behavior of governments influence the behavior of “normal” economic agents
Trade Policy: Demand & Supply Factors
Source: Rodrik (1995)
What Influences Governments?
• What are governments?
– Elected officials (politicians)
– “Professionals” (public servants)
• Main influences:
– Citizens in elections
– Lobbying• Casual
• Professional
• About 15000 professionals just in Brussels
– Corruption
– Individual preferences of government officials
Political Economy of Trade Policy
• Common (naïve) assumptions: – Consumers maximize utility
– Firms maximize profits
– Governments maximize national welfare
• Reality – additional motives/problems:– State/government is not a single homogenous entity – many different
interests (and even turf wars).
– Most governments use protection even though many models suggest that it decreases overall welfare
– Governments seem to prefer welfare of firms to welfare of consumers
– Authorities (and public) often seem to emphasize the role of exports and surplus in balance of trade
– Professionals can be more interested in keeping the job than achieving some result
• Can we explain reality in models based on these assumptions?
From a recent Bloomberg poll…
September 2016: Protests against TTIP in Germany
Source: http://www.bbc.com/news/world-europe-37396796
Lobbying and Collective Action
▪ Problem of lobbying – free riders
▪ Olson (1965): lobby organization is easier with fewer members, in more concentrated industries, with more similar members, with greater external threats
▪ Becker (1983): small groups will be successful in taxing larger groups for their subsidies
▪ Consumers are as a group much weaker than concentrated industries – there are many of them, very different in their preferences, potential benefits are low for each individual, it is easy to be a free rider
Lobbying: Not Just an Instrument…
▪ Assume an economy with inefficient protected industry, where liberalization is planned by government
▪ Firms in the industry knows that their survival is in danger
▪ Two solutions: To invest into new technologies and restructuring
To invest into a politician who is going to help the firm and postpone (cancel) liberalization
▪ Decision will depend on nature of political system and perceived probability and costs of success
▪ Problem – different long-term effects on efficiency and welfare
▪ Lobbying: an example of a DUP and rent-seeking activity
DUP Activities (Bhagwati) and Welfare
▪ Directly unproductive profit-seeking activities
= Profitable activities that attract “investment” without actually being productive, i.e. activities that use resources but yield zero output
▪ E.g. in case of tariff protection (quota is very similar): Tariff evasion (smuggling)
Tariff-seeking lobbying
Revenue-seeking lobbying
Typology of Models – Rodrik (1995) (1)
▪ Basic approach:
Take the HO model (or similar setup) and
Modify the objective function (preference for certain distributional impacts)
Introduce individuals or lobbies able to take actions to influence policymaker’s preferences
Typology of Models – Rodrik (1995) (2)
▪ Tariff formation function approach (Findlay & Wellisz, 1982) Tariffs are endogenously determined through a GE model which incorporates
influence of interest groups on the tariff determination process
▪ Political support function approach (Hilman, 1989) Extension of the previous approach Policy-maker maximizes a welfare function which trades off the industry gains
from protection against the losses to the population
▪ Median-voter approach (Mayer, 1984) Political decisions reflect the self-interest of voters, lobbying groups, politicians
and other decisionmaker Endogenous formation of interest groups
▪ Campaign contribution approach (MBY, 1989, Grossman-Helpman, 1994) MBY: lobbies contribute to the political campaign of a particular party so as to
increase the probability of election
▪ Political contribution approach (Grossman-Helpman, 1994) Small open economy with a political incumbent confronted by many lobbies’
contribution schedules
A Few Specific Features…
Election and Median Voter
▪ Voters ranked by gain/loss from the suggested change in trade policy▪ Median voter loses – politicians minding the probability of being reelected
should reject the proposal▪ But – how to explain that minorities (e.g. producers) and not the majority
seem to profit from some existing policies?
0 10.5
L
G
Rational Ignorance & Rational Abstention
▪ Rational ignorance/inattention Gathering and evaluation of information is costly
Direct benefits from political participation are mostly fairly low
Direct importance of each individual vote tends to be fairly low
▪ Isn’t it rational to remain ignorant or even to abstain from voting completely?
▪ Motivation for abstention/free-riding does not have to be distributed evenly
Rent-seeking?
▪ Voters ranked by gain/loss from the suggested change in trade policy
▪ Overall welfare impact negative, but loss for majority fairly low while gain for the minority high
0 10.5
L
G
Fernandez & Rodrik (1991)
▪ “Simple” question: Why do governments so often fail to adopt policies which economists consider to be efficiency-enhancing? Real reforms sometimes happen against the will of the local business
even if it eventually profits from the reform!
Most real reforms happen only on “special occasions” (deep crisis, revolutions, coups)
▪ Model of trade liberalization
▪ A rational explanation can be based on uncertainty regarding the distribution of gains and losses from reform Some of the individual gainers and losers from reform cannot be
identified beforehand.
This leads to a bias towards the status quo.
▪ There can be a difference in ex ante and ex post viability of reforms
Fernandez & Rodrik (1991)
▪ Interesting features:
The result does not depend on macroeconomic uncertainty
It does not require risk aversion either!
Fernandez & Rodrik (1991) - details
▪ The basic model explains why people can vote “incorrectly” – but not why there is a bias against trade policy reforms
For this they introduce the second round: and the risk of reform reversal
Simple DemonstrationFernandez and Rodrik (1991): Trade Liberalization Model
▪ Assumptions: Infinite horizon with discount rate δ
Individuals face a reform where they all have the same ex ante probability p of gaining from reform and getting a net-present-value payoff of g > 0 and the probability 1 − p of losing from reform and getting a net present value payoff of l < 0.
Uncertainty is purely individual, p is also the percentage of ex post winners from reform
The status quo payoff is assumed to be 0.
At t = 0, individuals vote on whether or not to implement the reform.
At t = 1, they can vote on whether or not to implement the reform if it was accepted at t = 0 (they incur a cost ξ in this case).
Assume that l < −ξ so that losers always prefer to reverse the reform.
Simple DemonstrationFernandez and Rodrik (1991): Trade Liberalization Model
▪ p > ½ Majority will favor reform ex post and oppose any reversal to
the status quo at t = 1.
But assuming risk neutrality, if pg + (1 − p)l < 0 , the reform will be rejected ex ante by all.
Since they know that the reform will not be reversed once it is decided, it will never get decided as soon as the expected payoff is negative even though a majority would benefit ex post.
Possibility that reforms benefiting a majority ex post are rejected ex ante!
Simple DemonstrationFernandez and Rodrik (1991): Trade Liberalization Model
▪ p < ½ A majority will always want reversal ex post. Even if pg + (1 − p)l > 0, as soon as the reversal cost is higher than the
expected one-period payoff, that is, as soon as ξ > (1 − δ)[pg + (1 − p)l] (which is always true for δ →1), the reform will not be adopted either.
People will know that the reform will be reversed with probability 1, so the net payoff from reform is (1 − δ)[pg + (1 − p)l] − ξ < status quo payoff of 0
▪ For reforms to take place, they must satisfy both the ex ante and the ex post political constraint. In all other cases, reform is not adopted.
▪ Status quo bias against reform!
Uncertainty & Reversals: Exercise
▪ All individuals in our model world live for 5 periods.
▪ If nothing happens, every single individual in our world will have income equal to 100 in each of the periods
▪ You are a politician thinking about introducing a simple reform in period 1
▪ People will be voting about the reform ex ante (in a referendum), i.e. at time 0 At the time of the voting they are provided with predictions of the results. We assume that they believe the predictions Thus they “know” that the reforms will increase the incomes of 80% of the people to
110, while incomes of 20% of the people will drop to 90 for periods 2, 3, 4, 5.
▪ They will also have a chance to vote about the reform again at the end of period 2 (when they know the income for period 2 already)? If the reform is reversed, they will return to the original income of 100 in periods 3, 4, 5 However, they will also face “reversal costs” which will reduce their income in period 3
by 11.
▪ Let us also assume that individuals do not discount the future (δ = 1)
▪ If the reform had been adopted already, will it survive the second vote at the end of period 2?
▪ Will the reform be adopted in the first place?
Solution Details
Period 1 Period 2 Period 3 Period 4 Period 5 Total
Lucky 80% 100 110 110 110 110 540
The other 20%
100 90 90 90 90 460
Average inc.
100 106 106 106 106
No reform Period 1 Period 2 Period 3 Period 4 Period 5 Total
Lucky 80% 100 100 100 100 100 500
The other 20%
100 100 100 100 100 500
Reform accepted, no reversal
Reform accepted, but reversed
Period 1 Period 2 Period 3 Period 4 Period 5 Total
Lucky 80% 100 110 89 100 100 499
The other 20%
100 90 89 100 100 479
Average inc. 100 106 89 100 100
Reversal Analysis
Decision about the reversal:
Continuation Reversal
Winners (80%) 330 289
Losers (20%) 270 289
Reversal should not happen.
Voters are likely to be willing to vote for the reforms ex ante (period 1).
No reform
Reform, reversal
Reform without reversal
500, 500
Lifetime incomes of the “winners” and “losers”
540, 460
489, 479
Reform accepted, no reversal happens.
Uncertainty & Reversals: Exercise
▪ All individuals in our model world live for 5 periods.
▪ If nothing happens, every single individual in our world will have income equal to 100 in each of the periods
▪ You are a politician thinking about introducing a simple reform in period 1
▪ People will be voting about the reform ex ante (in a referendum), i.e. at time 0 At the time of the voting they are provided with predictions of the results. We assume that they believe the predictions Thus they “know” that the reforms will increase the incomes of 40% of the people to
200, while incomes of 60% of the people will drop to 95 for periods 2, 3, 4, 5.
▪ They will also have a chance to vote about the reform again at the end of period 2 (when they know the income for period 2 already)? If the reform is reversed, they will return to the original income of 100 in periods 3, 4, 5 However, they will also face “reversal costs” which will reduce their income in period 3
by 11.
▪ Let us also assume that individuals do not discount the future (δ = 1)
▪ If the reform had been adopted already, will it survive the second vote at the end of period 2?
▪ Will the reform be adopted in the first place?
Solution Details: Version 2
Period 1
Period 2 Period 3 Period 4 Period 5 Total
Lucky 40% 100 200 200 200 200 900
The other 60% 100 95 95 95 95 480
Average inc. 100 137 137 137 137
No reform Period 1 Period 2 Period 3 Period 4 Period 5 Total
Lucky 40% 100 100 100 100 100 500
The other 60%
100 100 100 100 100 500
Reform accepted, no reversal
Reform accepted, but reversed
Period 1 Period 2 Period 3 Period 4 Period 5 Total
Lucky 40% 100 200 89 100 100 589
The other 60% 100 95 89 100 100 484
Average inc. 100 137 89 100 100
Reversal Analysis
Decision about the reversal:
Continuation Reversal
Winners (40%) 600 289
Losers (60%) 285 289
Reversal always happens (it benefits 60% of the population!).
But people may still be willing to support the reforms in the first vote (check the
expected value of the future income)
No reform
Reform, reversal
Reform without reversal
500, 500 (500)
Lifetime incomes of the “winners” and “losers”
(Brackets: average lifetime income)
900, 480 (648)
589, 484 (526)
If the reform is accepted, reversal happens.
Option 3
▪ Let’s keep the previous parameters, but reduce the gains of the “lucky” voters from 200 to 130
▪ What will the threat of reversal mean in this case?
▪ You can check the excel file for the results of this third version.
Complex Models….
Endogenous Trade Policy Models
• Magee, Brock, Young (1989), first papers - 1973
• Protection may be inefficient from the economic point of view,
but it is definitely politically efficient!
• Endogenous theory attempts to explain how economies
generate redistributive policies and the levels of lobbying
resources which are expended as the well organized work to
exploit those who are not in lobbies
• Wealth comes from two sources:
– Production
– “Predation / parasitism”
• Individuals will invest in both production and predation until
marginal returns from each are equalized
Magee, Brock and Young Model
▪ GE 2x2x2x2 model with: Two goods (capital intensive (X), labour intensive (M))
Two factors (K, L)
Two lobbies (for capital and for labour)
Two political parties (for capital and for labour)
▪ All agents – maximizing behaviour
▪ Export subsidy from the pro-capital party in exchange for campaign contributions from the capital lobby
▪ Protection – pro-labour party (contributions from the labour lobby)
▪ Lobbies – maximize factor incomes of their members (no free riding in lobbies)
▪ Parties – maximize probabilities of election
▪ Individual voters – rationally ignorant
MBY Implications
▪ Trade policy endogenous, it is an equilibrating variable
▪ Simulations: 5-15% of an economy’s labour and capital lost in rent-seeking
Prisoner’s dilemma equilibrium occurred about 40% of the time
▪ Ability to explain some 75% of variation in national tariff rates
▪ Problems and issues: Differential power question
Non-transparency
Waste x information trade-off
Welfare impossibility theorem
▪ Magee: economic costs of lobbying and rent-seeking are just the transaction costs of running democracy
▪ Welfare implications?
References
▪ Regional Trade Agreements: Goods rules: http://www.wto.org/english/tratop_e/region_e/regatt_e.htm
▪ Statistics on EU antidumping cases: http://ec.europa.eu/trade/issues/respectrules/anti_dumping/stats.htm
▪ Antidumping in relations between China and EU: http://econ.kuleuven.be/licos/DP/DP2002/DP119.pdf
▪ Green Paper: Europe's trade defence instruments in a changing global economy: http://eur-lex.europa.eu/LexUriServ/site/en/com/2006/com2006_0763en01.pdf
▪ Sadni-Jallab et al: An Empirical Analysis of US and EU Antidumping Initiation and Decision http://www.uoregon.edu/~bruceb/Mus1.pdf
▪ Puga and Venables (1995): Preferential trading arrangements and industrial location. CENTRE for ECONOMIC PERFORMANCE Discussion Paper No. 267, October 1995
Thanks for your Attention
Questions?
